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This is why Spotify risks bankruptcy

This is why Spotify risks bankruptcy

February 14, 2017 / No Comments

This guest blog is by Karl-Johan Byttner. Earlier this month, the tech world was shaken when news emerged that Spotify’s IPO would likely be delayed until 2018, according to multiple high-level sources.

Very quickly, existential questions have risen around the Swedish music streaming giant’s future. Speculation in industry circles and international press indicate it could be just a matter of time before the bell tolls for Spotify.

What looks like a delayed IPO is raising questions in particular about the company’s business model.

A big question is whether Spotify will be able to secure new agreements with the big music labels. But one problem overshadows them all:
Spotify is not yet turning a profit.

Undoubtedly, Spotify is leading the charge for digitizing and modernizing the music business.

Industry website Digital Music News concludes that Spotify is ”incredibly good at what it does” and beats the competition. In the past few years it has scaled to more than 100 million users; 40 million of them paying Premium customers. Founder and CEO Daniel Ek has made it to the industry magazine Billboard’s Power 100 list.

But Spotify could be facing a harsher reality after its IPO hiccup, which was brought on by Wall Street’s reluctance to go through with the deal.

“They’re growing quickly, but their underlying finances are rotten. [..] Three to five years ago, you could have an IPO based solely on user growth and promises of the future,” one source said to TechCrunch.

“But the financial climate has changed now. Today you have to show some path to profitability, especially at the valuation that Spotify has been targeting. That may have caught up with the company a bit.”

Spotify must negotiate renewed license agreements with three music giants – Universal, Sony and Warner – to avoid losing big parts of its content, according to BBC.

Documents from last year show that since being founded in 2006, Spotify had paid $5 billion in royalty fees.

Spotify pays sometimes up to 70% of its revenues to the record companies as royalties, and pays additional fees to the music companies on top of that. Hence the company’s future may depend on whether the music giants will bend, according to Digital Music News.

Spotify’s ambition is to reduce the royalty share in order to turn profitable, but the BBC points out that artists are likely to resist considering they already see royalties as low.

That was the reason Taylow Swift removed herself from Spotify, for example.

That’s not the only headache for Spotify; if the company waits too long with its IPO it could run out of cash. Moreover, Spotify had been wanting to buy the competitor Soundcloud, but backed out of the deal at the end of last year, possibly because of cash-flow concerns.

In March 2016, Spotify raised $1 billion from investors with the following terms: an interest of 5% and a 20% discount on stock if the IPO comes to be. The agreement also stipulates that the interest rate and discount should increase with 1% and 2.5% respectively for every six-months the IPO is postponed.

In other words, time is of the essence – the margins have to be improved. Spotify has to show a clear path to profitability, especially considering the valuation the company is aiming for. It has been speculated that Spotify could be worth SEK 450 billion ($50bn) by 2020.

At the same time there are contradictive reports from TechCrunch that claim the postponement of the IPO mean that Spotify has more time to “build a better accounts balance and work on improving the business model to improve the margins.”

The BBC concludes that Spotify is headed towards a dark future unless Daniel Ek can find a solution to the precarious situation.

What’s more, with Donald Trump as president of the United States, life for Spotify has become even more difficult. While Spotify is hoping for deregulation and tax cuts, Donald Trump has clearly said ’America First’, which could pose risks for foreign companies.

But, as Billboard writes, the whole music industry has an interest in seeing Spotify succeed, but adds:

“If Spotify isn’t too big too fail, it’s quickly headed in that direction.”

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